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Action Call and Urgent Message from Scott Richardson, President and CEO of IZALE Financial Group:​

To Clients, other businesses and their stakeholders, and our industry colleagues: this is a must read summary of the House tax bill that was released on November 2, 2017.

​While the contents of any bill are far from certain, if this bill becomes law, employers’ ability to retain and reward key talent will be profoundly impacted. Call your Congressman and Senators and express that concern! Please use our Social Media share buttons to educate your peers on this rapidly evolving issue.

Saturday, November 4, 2017 ~ Special Edition

This report provides K&L Gates' initial executive summary of Section 3801 of the Tax Cuts and Jobs Act, which would virtually eliminate the NQDC market and have broad impacts on a number of common compensation arrangements across our economy.​Section 3801 Increases Taxes on Savings and Fundamentally Alters Compensation Plans in America

Section 3801 of the Tax Cuts and Jobs Act created a new section,Internal Revenue Code §409B,which:

Eliminates ability to defer compensation for all U.S.-taxpayer employees and other service providers (directors and consultants) at all levels of for-profit businesses—start-ups, private companies, public companies, etc.

Applies to all levels of service providers, not just high-paid executives

Requires income to be recognized when compensation is no longer subject to a “substantial risk of forfeiture” (SRF), with a narrow definition of SRF:

SRF can be based only on requirement to provide substantial future services

Specifically excludes SRF based on compliance with a non-compete (as otherwise permitted under IRC §83)

Broadly defines “nonqualified deferred compensation” (NQDC) to include any amounts that could be paid later than March 15 of the year after the year the SRF lapses, with explicit exceptions for qualified retirement plans, certain welfare benefit plans (e.g., vacation and disability), and transfers of property (excluding options) subject to IRC §83, and specifically includes as NQDC:

stock options and stock appreciation rights

restricted stock units and other forms of phantom equity

Applies to all compensation earned for services beginning January 1, 2018 (immediate)—requires end of all pre-2018 deferrals by end of 2025

§409B Would Adversely Impact U.S. Businesses, Employees, and Shareholders

The following lists some of the potential adverse consequences of §409B:

U.S. businesses will be less competitive globally because of the limited flexibility to compensate employees as compared to the majority of industrialized nations.

Millions of U.S. employees—not just top-paid, public-company executives—may experience (1) lower pay due to reduced equity and performance-based incentive opportunities, (2) reduced retirement benefits, and (3) higher taxes due to lost deferral opportunities.

U.S. businesses will find it significantly more difficult to align employee pay and long-term shareholder interests, which will harm shareholders, businesses, and employees.

Employees’ ability to share in the long-term success of their employers will be severely limited.

Employees will be incentivized to focus on short-term performance at the expense of long-term performance.

Compensation techniques for discouraging excessive risk-taking will be significantly limited.

§409B Would Effectively Eliminate Many Common Compensation Practices

The following widespread and long-standing forms of compensation would effectively be eliminated or dramatically curtailed by §409B:

Stock-based awards designed to provide income protection at death, disability, or retirement and align to shareholder interests through retirement

Severance arrangements intended to give income security to terminated employees for periods longer than 3 months

Retirement plans which provide retirement security at companies when 401(k) plans are not available or contribution limits are constrained

Other forms of retirement programs intended to make up for IRC limitations or provide long-term retention and incentives

​Many of these practices are especially common among small and private businesses, where the potential for growth and innovation is high but cash-flow and liquidity are constrained. These practices are also broad-based and allow employees outside of executive management to share in the upside of a growing company and save for retirement.

Additional Details on Adverse Impacts and Unintended Consequences

Stock Options and Phantom Equity. §409B would effectively eliminate the use of stock options, stock appreciation rights, and phantom equity (including RSUs) for all U.S. businesses. Stock options, in particular, are a foundational form of incentive compensation for businesses at all levels, in part because they are simple in concept, well understood, effectively align interests of employees with shareholders, and provide rewards only for actual value creation for shareholders. Forcing employees into §83 restricted stock awards as the only form of permitted equity compensation will be impractical for many start-ups/private companies/small businesses because it requires liquidity to pay taxes before the shares are liquid and when the companies need to preserve cash for growth. This will also be a global competitive disadvantage for U.S. business, as most industrialized economies in the E.U., Asia, and elsewhere recognize stock options as an appropriate form of incentive compensation.

Performance-Based Compensation. §409B would severely restrict both public and private companies in designing and implementing long-term, performance-based compensation plans (cash- and equity-based). It is commonplace in such plans to provide an opportunity for an employee to continue to vest in an award, subject to the ultimate performance outcomes, in case of certain terminations of employment, such as death, disability, or termination by the company without cause. §409B would apparently trigger tax at termination of employment (although it is unclear as to how the amount would be determined when performance has not been completed), which will severely hamstring design flexibility or eliminate the programs altogether. Such programs are broadly used both in private companies (typically as long-term cash awards) and public companies, where institutional shareholders strongly urge companies to adopt these types of programs as in the best interest of long-term shareholders. The programs are used with all levels of key employees, sales people, etc.—not just executives.

Other Retirement Plans. Many community banks and privately held businesses use supplemental retirement plans in lieu of equity compensation as a retention and incentive tool for top managers. These plans often provide make-up retirement benefits not available under qualified defined benefit or defined contribution retirement plans because of limits such as the $120,000 highly compensated employee definition or the $270,000 compensation limit. §409B would likely eliminate these plans or force the use of lengthy time-vesting schedules that hurt employees and diminish the retentive value (because employees tend to deeply discount the compensation value of amounts vesting longer than five years). Impacted employees at these companies are not wealthy executives at public companies. For community banks, these programs support bank regulatory principles by aligning employees with the interests of creditors and depositors in the bank.

Deferral Programs Supporting Risk-Management Practices. §409B is directly at odds with the regulatory direction of U.S. and E.U. banking regulators more generally, which have guidelines and rules that push financial institutions to have annual incentive compensation awards deferred for three-to-five-year periods in order to ensure that initial annual performance is sustainable and that risk management policies are observed by risk-takers. The concept of risk-takers goes well beyond executives and top-paid management and can include broad groups of employees in similar incentive plans. These principles have also been more broadly adopted outside of the financial services industry in response to institutional shareholder demands and to ensure that compensation programs properly support risk-management best practices. §409B as proposed would likely require a major re-design of these deferral programs and would likely significantly water down the effectiveness of the programs by forcing tax payments on amounts that would otherwise be subject to forfeiture/clawback for conduct contrary to risk-taking policies or in the event of subsequent financial restatements.

Salary Continuation/Severance. As proposed, §409B would apply to routine salary continuation/severance arrangements paying severance over periods as little as three months, forcing companies into lump sum severance payments. This would apply to employees at all levels, not just executives. Salary continuation serves several very reasonable business purposes, including providing companies with a tool to enforce post-employment covenants and to more easily administer post-employment health benefit arrangements by providing a ready source for deducting the employee portion of premiums.

Other Unintended Consequences. In the rollout of §409A, one key lesson was that the broad definition of NQDC in §409A (which is less broad than as proposed in §409B) can potentially and unanticipatedly impact a wide range of compensation arrangements impacting all employees, including various types of broad-based employee fringe benefit programs (like various types of service reward programs). Forcing early taxation on these types of programs will dampen innovative compensation design and create additional competitive disadvantages for U.S. businesses as compared to global competitors.​

The AALU WR Newswire and WR Marketplace are published by the AALU as part of theEssential Wisdom Series, the trusted source of actionable technical and marketplace knowledge for AALU members—the nation’s most advanced life insurance professionals.

About K&L GatesK&L Gates is a fully integrated global law firm with lawyers located across five continents. Our broad global platform allows us to guide clients through the legal challenges inherent in the ever-changing international landscape. The deep latticework of relationships across our offices and practices enables our clients to respond to diverse legal issues and risks through the services of one law firm with a single communication. Read more here.​

DISCLAIMERThis information is intended solely for information and education and is not intended for use as legal or tax advice. Reference herein to any specific tax or other planning strategy, process, product or service does not constitute promotion, endorsement or recommendation by AALU. Persons should consult with their own legal or tax advisors for specific legal or tax advice.

written by Steve Fichtenbaum, LLM of Steven J. Fichtenbaum Esq.

SUMMARY: The taxpayer inherited a non-qualified annuity from his father and wished to exchange the annuity for a new annuity issued by another insurance company. He assumed the exchange would be tax-deferred under Code Section 1035, but he failed to exchange annuity contracts as required by Section 1035. Instead, he cashed in the inherited annuity contract, taking a lump sum from the original insurance company, and deposited the proceedsinto his checking account. He then used the proceeds to purchase a new annuity. Informed of his mistake by his accountant, the taxpayer requested a private letter ruling from the IRS requesting favorable (no taxable event) treatment on the transaction. The IRS ruled the distribution was taxable in the year it was received to the extentdetermined under Code Section 72(e).

RELEVANCE: The result in this ruling should not be a surprise to life insurance professionals. Code Section 1035(a) allows the exchange of a life insurance contract for another—or a deferred annuity for another—generally without requiring recognition of gain upon the exchange. However, failure to understand and follow the technical requirements of Code Section 1035 can lead, as it did here, to an unanticipated adverse result. While lenient rulings involving partial exchanges of annuities have been accorded Section 1035 exchange treatment (See Rev. Proc. 2008-24 as amended by Rev. Proc. 2011-38), the Service has for the most part required certain formalities to be strictly followed to accomplish the appropriate tax deferral.

MARKET TREND: Despite explicit prohibitions on taking loans from IRAs, some IRA holders have used rules applicable to tax-free rollovers to effectively “borrow” amounts held in their IRAs for short periods – generally, up to 60 days. A recent Tax Court decision and follow-on guidance from the IRS, however, will now limit this method of access to IRA funds.

SYNOPSIS: In Bobrow v. Commissioner, the Tax Court recently concluded that the rollover treatment that allows taxpayers to take money out of, and repay money to, IRAs on a tax-free basis is limited to one rollover per 12-month period per taxpayer, regardless of the number of IRAs held by the taxpayer. This ruling differs significantly from the previous IRS position, which applied the tax-free rollover rules on an IRA-by-IRA basis. After the Tax Court’s decision, however, the IRS issued Announcement 2014-15, indicating that it now will follow Bobrow’s interpretation of the IRA rollover rules.

TAKE AWAY: The Bobrow decision and the IRS’s revised position have significantly restricted an IRA holder’s ability to access his or her IRA funds on a short-term, tax-free basis. This, combined with the recent proposal to eliminate “stretch” IRAs found in both the draft “Tax Reform Act of 2014” and the President’s FY2015 Budget (see discussion in WRMarketplace#14-10), evidence that additional changes to the tax treatment of IRAs may be possible. Regardless, these savings vehicles currently remain important and popular tools for retirement planning. Thus, clients maintaining IRAs (and their advisors) must be aware of the IRS’s change in position to avoid inadvertent violations of the rollover rules, which could cause unexpected current taxation of amounts purportedly rolled over after December 31, 2014.

SUMMARY: In a bankruptcy proceeding concerning Racing Services, Inc., the bankruptcy trustee sought to have Racing Services’ interest in a split dollar life insurance policy liquidated to satisfy creditors. The bankruptcy court ordered the surrender of the policy. On appeal, the Eighth Circuit determined that the split dollar agreement did not give Racing Services the right to surrender the split dollar agreement or the policy, so the bankruptcy court did not have the right to order surrender of the policy to satisfy Racing Services’ creditors either.

SUMMARY: A taxpayer with modest income surrendered a policy on his life. On that date, the policy was subject to a significant loan. The Tax Court held that the amount of the loan in excess of the taxpayer’s investment in the contract was includible in his income and was not excludible as a discharge of indebtedness even though he was insolvent. The judge then applied a three-factor test in finding taxpayer was not liable for an accuracy-related penalty because of good faith and reasonable reliance on professional advice.

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​Effective June 9, 2017, all individuals who provide advice to retirement plans, including Individual Retirement Accounts (IRAs), must abide by the fiduciary standard. What does the fiduciary standard mean? This means that your advisor must put your interests first before their own or that of the firm, make prudent recommendations, charge reasonable compensation and make no misrepresentations to you regarding recommended investments. The recommendations made by your advisor must be based upon your specific investment needs and objectives. The fiduciary standard is applicable to any recommendations that your advisor makes to you, the client, for your retirement account.

Please note the firm does have policies and procedures in place to monitor this level of fiduciary responsibility for our clients.

IZALE Financial Group does insurance business in California as IZALE LLC Insurance Agency

This site is published for residents of the United States only. Representatives may only conduct business with residents of the states and jurisdictions in which they are properly registered. Therefore, a response to a request for information may be delayed until appropriate registration is obtained or exemption from registration is determined. Not all of services referenced on this site are available in every state and through every advisor listed. For additional information, please contact Scott Richardson at 855-492-5334.